When it comes to the more important decisions in life, people tend to spend a lot of time making a very careful choice, then sticking with it. Although it's possible to make rapid-fire marriage and divorce decisions (witness Britney Spears), most people find happiness in long-term commitments. I think Fools should follow suit in their investing decisions, actively seeking "one-decision stocks."
What's a one-decision stock?
Some stocks trade at such compelling prices that one good buying decision will provide a lifetime of outperformance. Ben Graham's investment in GEICO (later passed on to Warren Buffett's Berkshire Hathaway
Fashion changes quickly. So does technology. These industries make me nervous, because they change too quickly. The other day I was using my iPod mini and Friendster account, and now all of a sudden, it's all about the iPhone and Facebook. I can barely keep up, and neither can my portfolio.
Instead, I like industries where change occurs really ... really ... slowly. Some habits die hard. I'm pretty sure that in 30 years, humans will still grow hair on their faces, and need to shave it off. Thus, I hardly need a crystal ball to predict a healthy demand for Procter & Gamble's
Stable market share
Large companies' pricing power and economy of scale usually mean that their market share tends to determine their profit share. To evaluate a company's market-share prospects, ask the following questions:
- What's the current market-share breakdown, and why is it distributed that way?
- Are there barriers to entry?
- How much do industry participants compete on price, distribution, service, or relationships?
- Are the relationships and contracts involved long-term or short-term?
- If I were a competitor armed with a huge bankroll, could I make a dent in this company's market share?
The answers will considerably help in estimating a company's future market share.
The right culture
Winning cultures tend to stay winners, and vice versa. When's the last time you saw a championship sports player leave a winning team to play for a perennial loser? Good people attract good people, and in business, that helps to grow a company's intrinsic value.
Capital allocation policies are a good way to judge management's prowess. I've noticed that big Buffett and Lampert holdings, such as Stock Advisor selection Moody's
High returns on capital
I don't believe that investors should consider companies with low returns on capital as permanent holdings. In the long run -- 5-10 years or more -- a company with low returns on capital simply can't expect high performance from its stock price.
A reasonable price
If a company fits all of the above criteria, then it's probably at least a very good company. Best of all, if you can buy a firm like this at a "normal" price, you're probably getting a bargain.
For example, an average company might trade at 10-15 times earnings, equating to a 6%-10% earnings yield. Adding growth to that percentage provides a quick-and-dirty long-term return calculation. Great companies can steadily increase earnings over the long run in the 7%-13% range. Combine that growth with a 6%-10% earnings yield, and our hypothetical stock's annual appreciation rate would lie in the 13%-23% range.
That's an admittedly oversimplified way to calculate a potential return. But in general, if you can buy a great company that meets the above criteria, sporting a decent earnings yield and healthy growth rates, it's hard not to make money in the long run. And if you find such a company, there's no reason not to hold onto it for a long time.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool's disclosure policy is a keeper.